The fund returned 0.5% in September, bringing its total return to 5.3% for the year and 7.5% for the 12-month period. This is ahead of the returns delivered by both cash (6.9%) and in line with its benchmark (7.6%) over the same one-year period.

After a brutal August, September provided a reprieve for South African bond markets, although the aggregate performance was still negative. The All Bond Index fell 0.4% and weakness was concentrated in longer-dated bonds (12+ years) that lost 0.7%. This was followed by the belly of the curve (7-12 years), which was essentially flat over the period. Short-dated bonds performed better, up 0.6%, while inflation linkers returned 0.5%. Cash returned 0.6% in September.

Market news during September was dominated by increasingly mixed global activity data, while emerging markets were able to take a breather. In the US and Japan, growth momentum remains strong, with signs of moderating activity in Europe and the UK. Within emerging markets, a combination of Turkey's rate hike and fiscal plan as well as Argentina's International Monetary Fund arrangements helped provide some stability, while activity data from China showed a moderation. Trade tensions are ongoing, but the late-month trade agreements (NAFTA 2.0) between the US, Canada and Mexico may diffuse some of the related tension. However, trade aggression with China is expected to escalate in coming months, presenting downside risk to global growth momentum.

A closer look at the economic data shows growth in the US remaining strong, although running estimates for the third quarter of 2018 are slower than the robust GDP print for the second quarter. Available data for the third quarter suggest a modest moderation to about 3.2% as the initial fiscal boost to consumption fades and the trade deficit widens again. In August, consumer prices as measured by the Personal Consumption Expenditures Price Index, rose 0.2% month-on-month, both at the headline and core levels. The annual pace of headline inflation was unchanged at 2.2%, while that of core inflation was 2.0%.

The Federal Open Market Committee (FOMC) raised the Fed Funds rate 25 bps to a range of 2.0% - 2.3% in September, with the notable change to the statement being the removal of the word 'accommodative' in their description of the current monetary policy stance. At this time, an additional 25 bps rate hike is expected at the December meeting, and the central tendency on the dot plot implies four more hikes in 2019.

Inflation surprised to the downside in August, at 4.9% year-on-year from 5.1% year-on year. Food inflation remains very low, and despite isolated pressure on retail fuel prices, both general goods and services price pressure in a weak economic context remains subdued. Core inflation was unchanged at 4.2% year-on-year. The South African Reserve Bank's (SARB) Monetary Policy Committee (MPC) left the repo rate unchanged at 6.5% in September, but voted 4:3 to not hike 25 bps. The hawkish stance represented by this vote, especially in the face of weak growth and acknowledged absence of demand pressures, suggests the SARB may be willing to sacrifice growth in the short term for tighter policy and a longer-term moderation in expectations. This increases the risk of a 25 bps hike in November.

At the end of July, shorter-dated fixed-rate negotiable certificates of deposit (NCDs) traded at 8.7% (three-year) and 9.3% (five-year) down slightly over the month. The spreads of floating rate NCDs have dulled in appeal over the last few quarters, due to a compression in credit spreads. There has been a reduced need for funding from banks in South Africa, given the low growth environment. Fixed rate NCDs continue to hold appeal due to the inherent protection offered by their yields and relative to our expectations for a stable repo rate. However, credit spreads remain in expensive territory (less than 100 bps in the three-year area and 110 bps in the five-year area). The fund continues to hold decent exposure to these instruments (less floating than fixed), but we will remain cautious and selective when increasing exposure. NCDs have the added benefit of being liquid, thus aligning the liquidity of the fund with the needs of its investors.

South Africa's activity data have improved modestly. Manufacturing production was much better than forecast in July, up 2.9% year-on-year, but mining production was very weak, contracting -5.2% year-on-year after 3.7% year-on-year expansion in June. Business confidence for the third quarter remained weak at 37 from 28 in the prior quarter. Customs trade surprised with a bigger surplus than in July at R8.7 billion from a deficit of R4.7 billion in July. However, forward-looking PMI data for September was also disappointing, with the headline at 43.2 from 43.4 the month before. South Africa didn't differentiate itself during the quarter. Economic conditions worsened, with growth materialising below both ours and market expectations (-0.7% versus 0.9% expected), which pushed the economy into a technical recession. In the context of the weaker emerging market backdrop, South Africa did not fare well, as is evident by the poor performance of the rand over the quarter, but South Africa's problems are by no means as severe as those of Turkey and Argentina. Once the panic eased, both the rand and local bonds recouped some of their losses.

The rand was down 3% over the quarter, ending at R14.15 to the US dollar. Emerging market sentiment soured continuously during the quarter, following aggressive sell-offs in the Argentinian peso and Turkish lira. Combined with continued uncertainty on South Africa's land reform policy and poor growth numbers, this propelled the rand to its weakest levels in two years. The fund maintains its healthy exposure to offshore assets, and when valuations are stretched, it will hedge/unhedge portions of its exposure back into rands/dollars by selling/buying JSE-traded currency futures (US dollar, UK pound and euro). These instruments are used to adjust the fund's exposure synthetically, allowing it to maintain its core holdings in offshore assets. (It has the added benefit of enhancing the fund's yield when bringing offshore exposure back to rand.)

The euphoria of the first quarter has quickly faded as policy uncertainty remains a key obstacle to South Africa's recovery. Policy trajectory and the intentions of policymakers, have moved in the right direction, however uncertainty on land expropriation without compensation and mining regulations have impeded the translation of confidence into actual spending. Towards, the end of the quarter, a new, more acceptable version of the Mining Charter was released which should ease concerns from the mining sector in South Africa. However, to see an increase in consumption spending, currently contracting quarter-on-quarter, more clarity on land reform is required. Given the current rhetoric from policymakers, this should be resolved over the next couple of quarters, which will then help with a faster recovery in growth in 2019.

Recent economic releases have suggested that the local economy is taking much longer than initially anticipated to move onto a sustainable growth path. South Africa's longer-term growth prospects are being dimmed by shorter-term uncertainty on key policies. Policy pronouncements more recently have signalled policymakers' intention for a more market-friendly outcome, which should put growth back on an upward trajectory. Local inflation should remain within the target band, even after the recent sell-off in the local currency and rally in the oil price. Local government bonds, which provide an attractive return relative to cash, compare favourably relative to their emerging market peer group and offer a decent margin of safety against a shorter-term deterioration in fundamentals. At current levels, the yields on offer in the local bond market are attractive relative to their underlying fundamentals and warrant a neutral to overweight allocation.

The local listed-property sector was down 2.6% in September, bringing its return for the rolling 12-month period to -14.2%. Despite the underperformance over the last few quarters, from a valuation perspective, the sector is still very attractive. The changes in the property sector over the last decade (including the increased ability to hedge borrowings and large offshore exposures) have rendered the yield gap between the property index and the current 10-year government bond a poor measure of value. If one excludes the offshore exposure, the property sector's yield rises to approximately 10.3%, which compares very favourably to the benchmark bond. The fund maintains holdings in counters that offer strong distribution and income growth, with upside to their net asset value. In the event of a moderation in listed property valuations (which may be triggered by further risk asset or bond market weakness), we will look to increase the fund's exposure to this sector at more attractive levels.

The preference share index was down 1.1% in September, bringing its 12-month return to 4.1%. Preference shares offer a steady dividend yield, linked to the prime rate and, depending on the risk profile of the issuer, currently yield between 9% and 11% (subject to a 20% dividends tax, depending on the investor entity). The change in capital structure requirements mandated by Basel III will discourage banks from issuing preference shares. This will limit availability. In addition, most of the bank-related preference shares trade at a discount, which enhances their attractiveness for holders from a total return perspective and increases the likelihood of bank buybacks. Despite attractive valuations, this asset class will continue to dissipate, given the lack of new issuance and because it stands at risk of being classified as eligible loss-absorbing capital (only senior to equity). The fund maintains select exposure to certain high quality corporate preference shares, but will not actively look to increase its holdings. We remain vigilant of risks emanating from the dislocations between stretched valuations and the underlying fundamentals of the local economy. However, we believe that the fund's current positioning correctly reflects appropriate levels of caution. The fund's yield of 9.1% remains attractive relative to its duration risk. We continue to believe that this yield is an adequate proxy for expected fund performance over the next 12 months.

As is evident, we remain cautious in our management of the fund. We continue to invest only in assets and instruments that we believe have the correct risk and term premium to limit investor downside and enhance yield.

The fund returned 0.53% in June, bringing its total return to 3.54% for the year, 1.56% for the quarter and 8.20% for the 12-month period. This is well ahead of the returns delivered by both cash (7.0%) and its benchmark (7.71%) over the same one-year period.

What a difference a few months make. By the end of the first quarter of 2018, the world was in a happy place. Emerging markets were forging ahead, generating bond returns of 4.4% and equity returns of 1.4% (both in US dollar terms), and synchronous global growth was the rising tide that would lift all boats. Fast forward to the end of the second quarter and tears of disappointment are rolling down the faces of most emerging market investors. The sweet nectar that enticed and fuelled an insatiable hunger for yield in developing markets started to sour towards the end of April. Emerging market assets tumbled, spurred on by concerns of an overheating US economy and fears around the escalation of a US/China trade war, in turn fuelling a rally in the US dollar. This resulted in emerging market bonds and equities losing between 8% and 10% in the second quarter of 2018, bringing their dollar returns for the year to date to -6.44% and -6.60%, respectively.

The spirit of 'Ramaphoria' that prevailed during the first quarter of 2018 lost its momentum. In part, this was driven by disappointing growth data and a slowdown in the pace of policy reform implementation (as highlighted in last quarter's Bond Outlook). Coupled with the souring global environment for emerging markets, this resulted in the All Bond Index (ALBI) falling 3.8% in the second quarter of 2018, bringing its return year-to-date to 4% (marginally ahead of cash at 3.4%), but maintaining a solid double-digit return of 10.2% for the 12-month period. The South African 10-year government bond benchmark yield rose by almost 1% to 8.84% at the end of June (from its first quarter closing level of 7.98%), touching an intra-quarter high of 9.15%. The liquidation of bond holdings by foreigners resulted in a substantial swing in net bond flows, moving from a year-to-date net inflow figure of R17.6 billion (at 31 March 2018) to a net outflow of R35.6 billion (at end-June 2018). This had a significant impact on the exchange rate, with the rand weakening by 13.7% over the quarter.

The local economy has endured an extended period of underperformance relative to global markets and its peers in the emerging market universe. More recently, many of South Africa's self-imposed obstacles have started to show signs of clearing. Inflation remains at a cyclical low and should not exceed the top end of the South African Reserve Bank (SARB) target band (3% to 6%) over the next 12 to 24 months. In fact, current inflation expectations are closer to 5% than 6%, according to the latest Bureau for Economic Research Inflation Expectations Survey. Growth numbers for the first quarter of 2018 surprised materially to the downside (-2.2% quarter-on-quarter and 0.8% year-on-year), calling into question the realism of the 'Ramaphoria' effect. This implies that the SARB has room to provide more cyclical support to the local economy by further easing the repo rate; however, considering the recent rout in emerging markets, the worst-case outcome is that the repo rate remains stable for at least the next six to 12 months. On the growth front, although most recent data are cause for concern, real consumer income growth will be closer to 2% this year, allowing for an additional recovery in consumer spending, which makes up about 60% of GDP. Long term growth prospects will rely on an increase in fixed investment into the local economy, which can only be realised in a certain and transparent policy environment. The conditions thereof have been partially met with the new administrative team in government and newly announced policy reforms - although these reforms are likely to be implemented at a much slower pace than suggested at the start of the year. This leaves the South African economy in a very favourable position relative to its peer group, with growth heading higher and inflation being stable (or lower), thereby creating a supportive environment for local bonds.

At the end of June, shorter-dated fixed rate negotiable certificates of deposit (NCDs) traded at 8.53% (three-year) and 9.09% (five-year) respectively - up substantially over the quarter. The increase in fixed rates was due to the sell-off in fixed rate bonds and the market's repricing of repo rate expectations (moving from a 25 bps cut to a 25 bps hike). The spreads of floating rate NCDs have dulled in their appeal over the last few quarters, due to a compression in credit spreads. This was due to a reduced need for funding from banks in South Africa, given the low growth environment. Fixed rate NCDs continue to hold appeal due to the inherent protection offered by their yields and relative to our expectations for the repo rate (flat with a bias for a 25 bps reduction). However, credit spreads remain in expensive territory (less than 100 bps in the three year area and 130 bps in the five-year area). The fund continues to hold decent exposure to these instruments (less floating than fixed), but we will remain cautious and selective when increasing exposure. NCDs have the added benefit of being liquid, thus aligning the liquidity of the fund with the needs of its investors.

The rand was down 7.5% in June, ending at R13.73 to the dollar. Concerns around a possible trade war between the major global economies as well as the impact of higher developed market inflation on the current state of global monetary policy accommodation have continued to sour risk sentiment and the appeal of emerging markets and South Africa. This resulted in a synchronised sell-off of emerging market currencies, which coupled with large outflows from the bond market, dragged the rand to weaker levels. The current level of outflows, on a rolling 12-month basis, is equivalent to the level of outflows that the bond market experienced during the period May to June 2013 (the 'taper tantrum') and in the aftermath of 9 December 2015 ('Nenegate'). Given the degree of selling that has been experienced over the last 12 months (more specifically in the last three months), positioning seems a great deal cleaner (that is, not biased to a sell-off or rally in markets). This further suggests that big moves going forward are more likely to be valuation based rather than sentiment/positioning based. This further adds credit to our assertion that from current levels, bond yields are more likely to compress (bond rally) than widen (bond sell-off).

The fund maintains a healthy exposure to offshore assets, and when valuations are stretched, it will hedge/unhedge portions back into rands/dollars by selling/buying JSE-traded currency futures (US dollar, UK pound and euro). These instruments are used to adjust the fund's exposure synthetically, allowing it to maintain its core holdings in offshore assets. (It has the added benefit of enhancing the fund's yield when bringing offshore exposure back to rand.)

South Africa has made the mistake of looking through rose-tinted glasses for the better part of this year, with asset prices reflecting a much too optimistic outlook for local economic developments. The recent economic disappointments on growth have been a stark reminder of the local economic reality against a global backdrop that has turned more treacherous for emerging markets. South Africa's underlying economy remains in a better place relative to history and to its peer group. Inflation is expected to remain stable and well contained, while growth will continue to move higher. Local bonds have now adjusted to reflect realistic expectations for the local economy and the more unfriendly global environment. South African bonds compare favourably to their emerging market peers relative to their own history, and offer a decent cushion against further global policy normalisation. At current levels, the yields on offer in the local bond market are attractive relative to their underlying fundamentals and warrant a neutral to overweight allocation. The fund has been using the recent widening in bond yields to increase its allocation to fixed rate government bonds and hence its modified duration (capital at risk due to bond yield movements).

The local listed property sector was down 3.5% in June, bringing its return for the rolling 12-month period to -21.4%. Despite the underperformance over the last few quarters, from a valuation perspective, the sector remains very attractive. The changes in the property sector over the last decade (including the increased ability to hedge borrowings and large offshore exposures) have rendered the yield gap between the property index and the current 10-year government bond a poor measure of value. If one excludes the offshore exposure, the property sector's yield rises to approximately 10.3%, which compares very favourably to the benchmark bond. The fund maintains holdings in counters that offer strong distribution and income growth, with upside to their net asset value. In the event of a moderation in listed property valuations (which may be triggered by further risk asset or bond market weakness), we will look to increase the fund's exposure to this sector at more attractive levels.

The preference share index was up 1.6% in June, bringing its 12-month return to 1.8%. Preference shares offer a steady dividend yield, linked to the prime rate and, depending on the risk profile of the issuer, currently yield between 9% and 11% (subject to a 20% dividends tax, depending on the investor entity). The change in capital structure requirements mandated by Basel III will discourage banks from issuing preference shares. This will limit availability. In addition, most of the bank-related preference shares trade at a discount, which enhances their attractiveness for holders from a total return perspective and increases the likelihood of bank buybacks. Despite attractive valuations, this asset class will continue to dissipate given the lack of new issuance and because it stands at risk of being classified as eligible loss-absorbing capital (only senior to equity). The fund maintains select exposure to certain high quality corporate preference shares, but will not actively look to increase its holdings.

We remain vigilant of risks emanating from the dislocations between stretched valuations and the underlying fundamentals of the South African economy. However, we believe that the fund's current positioning correctly reflects appropriate levels of caution. The fund's yield of 9.25% remains attractive relative to its duration risk. We continue to believe this yield is an adequate proxy for expected fund performance over the next 12 months.

As is evident, we remain cautious in our management of the fund. We continue to invest only in assets and instruments that we believe have the correct risk and term premium to limit investor downside and enhance yield.